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Crude Oil Tumbles, Stock Traders Shrug it Off So Far

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August 2, 2016
Stock investors bear through the falling crude oil prices in the energy sector.

While the S&P 500 pushes to new all-time highs, the crude oil market is sagging under the weight of a continuing global supply glut. For now, stock investors appear to be shrugging off the weakness in crude oil with a "so-what" attitude. 

Increasing production from U.S. oil rigs in recent months, along with rising output from the Organization of Petroleum Exporting Countries (OPEC), has pressured crude oil from $50 per barrel in early June to near $40 a barrel early this week. 

Oil Supplies Remain Stubbornly High

"Supply still seems to be high and demand worldwide has stabilized," says JJ Kinahan, chief market strategist at TD Ameritrade. "Technically, oil has made a few runs at the $50 mark and failed which led to another sell off," Kinahan adds. 

The psychologically significant $50 barrel level proved to be a sticky ceiling for crude oil bulls. The market's inability to pierce that level triggered a bout of profit-taking on the sharp price run-up seen from February through June. 

The crude contract cracked initial 38.2% Fibonacci retracement support of the February to June rally late last week and is approaching a test of the 50% level at $38.64 this week. See figure 1 below for additional Fibonacci retracement levels. 

Stock-Oil Correlation Decoupled

In the first several months of 2016, the S&P 500 and crude oil futures moved in near lockstep, as the normally high correlation between oil and crude (around 70%) surged even higher hitting the 92% level. However, in recent weeks, as stocks score new highs, the equity market has decoupled from crude oil. 

"Recently, we have not had a high correlation. They have decoupled as oil prices have fallen," says Sam Stovall, managing direction at S&P Global Market Intelligence. 

Why? Early in the year, falling crude prices weighed on the stock market as some investors feared the weakness in oil was foreshadowing a potential economic recession, Stovall explains. 

Kinahan weighs in: "Although oil remains a major influence [on the stock market], we have seen many other things take its place over the last few months such as Brexit. Also, we have the election coming up which will be a major influence. The correlation to S&P 500 has gone from 92% to 71%." 

From an economic perspective, the recent pullback in crude oil prices could translate into lower gas prices at the pump, which is consumer-friendly. The national average for a gallon of gas at $2.13 at the start of August is down $0.15 over the last month and $0.53 lower from year ago figures, according to gasoline price website GasBuddy.com. 

“Despite high demand for gasoline, prices have continued to fall amidst an oversupply of gasoline across the country. High gasoline inventories, which are up 11.8% from this time last year, will continue to be a thorn in the side of refiners and a boost for consumers," says Will Speer, senior petroleum analyst with GasBuddy. 

With the energy sector, however, declines in the price of crude oil put pressure on drilling companies and exploration and production firms, Stovall says. "Should oil continue to fall it could mean less demand for new drilling," he says. 

For the short-term trading crowd, action around the 50% Fibonacci retracement level at $38.64 could be key to monitor this week in crude oil futures. If that cracks, the bears will target a retest of the 61.8% Fibonacci retracement at $35.65. Conversely, if the $40 per barrel level stands as support, crude oil may attempt to stabilize and consolidate its recent $10 slide. 

FIGURE 1: CRUDE OIL (/CL) FIBONACCI RETRACEMENT BRACKET.

Crude oil rallied from about $26 in February to $51 in June, leaving clear anchor points for this Fibonacci retracement bracket. Next levels of potential Fibonacci support include $38.64 and $35.65. Data source: CME. Image source: the TD Ameritrade thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.